Investment synthesis: new energy drives economies and investment portfolios globally

This is a chapter from the Franklin Templeton Institute paper, Energy transition: Accelerating investment opportunities. To read all chapters in this paper, download the complete PDF or click here.

Energy pricing, production and transportation significantly drive the global economy, with energy spending estimated at 13% of global GDP in 2022—a significant jump of 1.3X spending levels in 2018 and almost threefold the average from 1900 to 2020.¹ Low-cost energy is a growth engine for many economies, with low-cost renewables emerging as a primary new growth catalyst. As costs of renewables approach and continue to drop below traditional fossil fuel costs, numerous investment opportunities emerge.

New technologies are accelerating the renewable energy transition while reducing environmental impacts. The renewable energy sources of today and the future require new and smarter technologies as well as the rapid creation of new infrastructure. These challenges create investment opportunities throughout development and deployment cycles.

Energy as a keystone

Energy will be a key source of investment themes in coming decades because of its integral role in all functions of the global economy. Investment themes within energy will cover all aspects of its use, including production and storage.

This is a time of innovation in the sector—more than many investors realize. For investors, many fertile ideas can produce attractive investment results. The investments themselves will come in a variety of investment vehicles and capital structures. Investors need to be prepared to utilize both public and private instruments across asset classes. These types of investment opportunities require robust research to identify the best ideas and business plans.

As traditional energy sources shift toward newer technologies and options, an investor’s approach needs to adjust to identify the best opportunities across the industry given the potential risk and reward. In reviewing the exciting developments in the energy field within this piece, some key themes stand out as particularly strong, including innovations driving growth in the energy sector.

Nearer-term opportunity in bridge solutions

There are opportunities in both bridge solutions that temporarily fill in for traditional energy approaches as well as in long-term solutions for new, replacement energy technology and renewables. We see both contributing to the changing investable landscape of energy sources. Some of the bridge solutions that look attractive include natural gas, sustainable airplane fuels and increased energy efficiency from the use of artificial intelligence and battery storage.

Sustainable airplane fuels

As an example, aircraft are essential to economic trade, transportation and travel. Aircraft today are increasingly efficient, even as they account for 2% of human-generated carbon dioxide.² As the aviation industry seeks more efficient energy solutions, the use of sustainable aviation fuel (SAF) seems to be a widespread bridge solution. As standards become more stringent, companies may move to the use of high-blend (ratio of SAF in jet fuel) SAF, contributing to growth in industries supporting SAF, such as power-to-liquids (PtL) technology development and SAF production and blending infrastructure.

Natural gas

There is a need for bridge options between traditional fossil fuels and renewable fuels to fill a projected interim gap, as more stringent standards on the use of fossil fuels are combined with the lead time needed for renewable fuels to become available for general use. Natural gas is plentiful and burns the cleanest of traditional fossil fuels.³ It is likely to play a larger interim role in the transition to renewable energy sources as a result.

Artificial intelligence’s (AI) role in energy efficiency and cost-effectiveness

Irrigation challenges in agriculture

Agriculture accounts for 70% of the world’s freshwater use⁴–much of which must be moved from source to fields. In many cases, we still depend on ancient technology, such as dams and aqueducts, to move and store water. Getting water to the right place is challenging with such old “technology”—not to mention that water is heavy. As a result, moving water for agriculture accounts for nearly 20% of US energy consumption.⁵ Clearly, this is an area where gains can be made in the application of smart irrigation technology. Applying AI in irrigation technology could not only potentially increase crop yields by 7% to 9%; it could do so while also reducing energy consumption.⁶

Energy grids may bring new life to “boring” listed utilities

As an increasing percentage of the energy production mix comes from renewable sources such as wind, solar, geothermal or offshore hydro, these new sources need to be integrated into existing energy distribution grid systems. Additionally, these new renewable “farms” are often distributed across widely dispersed geographies, rather than centralized locations (read: power plants), like we have seen in most traditional fossil fuel–dependent sources. Moving energy to end users will therefore require expansion of power transmission networks. An increased demand for electricity in transportation and industry accompanies this growth. These combined forces require electrical network investment in areas such as additional storage, transportation and smart grids to optimize energy efficiency in real time. Smart grids can help manage the intermittent nature of many forms of renewable energy sources as well as manage the costs of bottlenecks within the networks.

Carrots, not sticks, create higher growth

Across the globe, many countries are implementing various approaches to energy transition ranging from sticks (regulatory taxes and fees) to carrots (as incentives). They are introducing these incentives at notably different speeds and subsidy levels. To fully understand a security’s valuation and earnings potential, analysts will need to understand and value the regulatory environment and the impact of either carrots or sticks on each firm’s projected earnings.

Subsidies create outpaced solar growth in Japan and Germany

Incentives (carrots) have spawned growth in new industries at a pace significantly faster than without them. For example, governments in both Japan and Germany offered loans and capital in the 1990s to incentivize solar development. Japan’s solar rooftop subsidy program, introduced in 1994, is credited with driving down costs of solar installations by more than 65% in the following decade.⁷ Germany implemented government feed-in tariffs to drive solar energy deployment in the 1990s through 2000s. These tariffs guarantee a certain level of financial benefit for each unit of electricity that renewable sources, such as solar panels, produce. Germany’s solar installations exploded, ranking it first globally among countries’ share of installed solar capacity.⁸

The “green vortex” is … Texas! Surprised?

The most well-known “stick” is carbon pricing, which has been implemented for decades, but rarely at scale. However, we are forced to examine the effectiveness of carrots when reviewing the impact of renewable energy growth in the US state of Texas. The phrase the “green vortex” describes the accelerating combination of technology advances based on the appeal of green profits that government subsidies kickstarted.⁹ Following an initial subsidy, these green-vortex businesses rely on classic incentives to direct capital to the best opportunities.

Why such interest in the impact of the green vortex? For the first quarter of 2022, Texas led the United States in renewable energy production, accounting for over 14% of the US total.¹⁰ Surprisingly, Texas, while still tied to its fossil-fuel industrial history, is producing almost twice the electricity from renewable sources as from coal.

Agglomeration accelerates a new scale in renewable industries

Agglomeration is a condition of vertically integrated supply chains with materials and steps of production designed to take place near to each other. China’s government employed agglomeration to incentivize solar panel manufacturing. Manufacturers were granted access to subsidized land and modern manufacturing infrastructure, which were partially financed with tax cuts and additional special financing. And key raw materials are located near production sites. This all aided in the achievement of scale, which lowers costs and improves quality.¹¹ The efforts in China, using incentives with agglomeration, led solar photovoltaic production to increase 500 times in 16 years.¹² As the renewable industries develop, watching for opportunities with agglomeration (in materials, supply chains and incentives/subsidies) should produce scale and payouts more quickly.

Many roads lead with hydrogen

Hydrogen is cited in a broad number of electric applications as a possible technology of the future. As with all new technologies, it is not clear how quickly challenges of production—high current cost, water use, storage and transportation needs—will be overcome. But the broad number of industries looking to hydrogen bears some research.

Hydrogen may fuel green steel as well as other industries

Currently, the steel industry accounts for 7% of global carbon emissions, but it could rise to 44% by 2050 if the industry’s traditional technology is not transitioned to cleaner fuels.¹³ Using green hydrogen—produced with renewable energy sources—in the manufacturing process could produce so-called “green steel,” and emissions could fall by 54% over this period. The challenge with this solution is the cost, which requires an investment of an estimated US$2.8 trillion to decarbonize the steel industry, globally.¹⁴

Emerging markets have the highest emission levels associated with steel production. The raw materials used to produce steel vary depending on a particular country’s stage of industrial development. In developed markets, steel production generally relies on scrap steel. But in emerging markets, where scrap steel is not as readily available, there is a greater reliance on iron ore and coal fired in a blast furnace to produce steel.

There are a number of industries with particularly high emissions that may also look to hydrogen for decarbonization. Some of them include fertilizer production, mining, cement, transportation and glassmaking.

Investing in renewables for a more energetic portfolio

The global economy’s shift toward more renewable energy is well underway, with a myriad of different approaches and technologies. There will be potential investment opportunities in bridge solutions and emerging technologies, as well as new and larger-scale renewable energy approaches. As companies grow or change, they will seek investment in various ways depending on their capital structure needed for growth. The scale of change is global and impacts not just energy but all business. Such a thematic shift creates many investment opportunities. An investor may find opportunities across the globe in public or private markets, across equity, debt and credit instruments. These plentiful opportunities represent unique approaches to reducing carbon use and increasing renewable energy supplies, storage and transportation. With careful research, we believe investors can identify good potential opportunities in the expanding energy industry.